Sometimes less is more. At least according to investment managers trying to navigate Europe’s credit markets.
TwentyFour Asset Management capped a bond fund to new investors at 750 million pounds ($1.2 billion) and JPMorgan Asset Management, which is marketing a 128 million-pound fund, said smaller investments are more flexible in a sell-off. Other managers are also limiting the size of their trades and using derivatives to avoid getting trapped in positions.
It’s become more difficult to buy and sell securities as Greece’s financial crisis curbs risk taking and dealers scale back trading activity to meet regulations introduced since the financial crisis. The Bank for International Settlements warned of a “liquidity illusion” in June because bond holdings are becoming concentrated in the hands of fund managers as banks pull back.
“Liquidity is generally poor in corporate bond markets and in the U.K. market it’s thin to zero,” said Mike Parsons, head of U.K. fund sales at JPMorgan Asset Management in London. “You don’t want to be in a gigantic fund where there’s potential for a lot of investors rushing for the exit at the same time. Smaller funds are more nimble.”
TwentyFour stopped accepting new investors for its Dynamic Bond Fund in April as liquidity waned, according to Chris Bowie, a portfolio manager at the London-based company. It’s still accepting money from existing clients and the fund now oversees 1 billion pounds of investment grade, high-yield and government bonds along with asset-backed securities and derivatives, he said.
“Without enough strong liquidity, it’s hard to execute bond trades in sufficient size or price to move portfolio risk around quickly or cheaply,” he said. “The bigger the position, the harder it is to find enough liquidity to sell it or buy it.”
TwentyFour separately started a 250 million-pound fund that will invest in pools of U.K. residential mortgages held by banks, Bowie said.
Liquidity in credit markets has dropped about 90 percent since 2006, according to Royal Bank of Scotland Group Plc. That’s because dealers are using less of their own money to trade as new regulation makes it less profitable.
Euro-denominated corporate bonds got an average of 5.3 dealer quotes per trade last week, up from 4.5 recorded in January and compared with a peak of 8.8 in 2009, according to Morgan Stanley data. That’s based on dealer prices compiled by Markit Group Ltd. for bonds in its iBoxx indexes.
“You have to be comfortable that you like your positions enough to hold them should market liquidity suddenly reduce for a period of time,” said Ben Bennett, a London-based credit strategist at Legal & General Investment Management, which oversees about $780 billion. “Long-term themes matter more in this environment.”
Investors pulled $2.3 billion from investment-grade bond funds in the week ending July 15, the biggest outflows since December 2013, according to a Bank of America Corp. report, citing EPFR Global data. They also withdrew money from high-yield funds for a sixth week.
Liquidity is especially bad in the U.K. corporate bond market, which is being abandoned by companies looking to take advantage of lower borrowing costs in euros and investors seeking securities that are easier to buy and sell.
U.K.-based asset managers should be even more concerned about their ability to unwind positions in corporate bonds during a period of market turmoil, Bank of England Governor Mark Carney said on Tuesday. The central bank surveyed 135 asset managers for a study on the impact of asset-management activities for global financial stability.
The Greek debt crisis may continue to damp liquidity for the next six months, according to Gildas Surry, a London-based analyst and portfolio manager at Axiom Alternative Investments, which oversees 500 million euros ($544 million) of assets.
NN Investment Partners said it seeks to manage difficult trading conditions by diversifying positions and capping trade size. The Netherlands-based asset manager avoids owning large concentrations of a single bond and uses derivatives such as credit-default swaps or futures that are easier to buy and sell, said Hans van Zwol, a portfolio manager.
“We really want to stay away from positions we can’t get out of,” he said.